Updated November 19, 2020:

The difference between partnership and S Corps (or S corporations) is the limited-liability protection for owners of businesses taxed as S-corps. Such liability protection is not available for owners of general partnerships and can only be claimed by some partners in a limited partnership. The S-corp arrangement also makes business growth easier by enabling the issuance of stock to new shareholders, which is hard in partnerships. However, partnerships benefit from relatively lenient taxation requirements and absence of stringent registration and maintenance requirements.

Partnerships and S-Corps

Both S-corp and partnership business concepts were designed for small and medium-sized businesses. Both business types do not pay corporate tax and therefore, owners are shielded from the double taxation of C corporations. However, the two business types are very different in structure, taxation, and liability treatment of the owners. 

The enabling laws for partnerships are created by states. Therefore, partnerships are regulated by the states in which they are formed. Conversely, the S corporation arrangement was created by the federal government. The S corporation is not an entity type, but rather a form of tax treatment that is available to some corporations. The key differences between partnerships and S-corps are discussed below.

Ownership

  • Ownership Laws
    In an S corporation, ownership is limited to U.S. citizens or residents. These limitations do not apply in a partnership. S corporations cannot have more than one class of stock; therefore incomes and losses are distributed according to the same criteria among all owners. Having one class of stock can prove to be an impediment when the business wants to obtain more capital. Partnerships, on the other hand, have some flexibility in the way profits and losses are distributed. 
  • Contributions of Owners
    The partner's contributions of appreciated property to the business is tax-free for all partners, but similar contributions by S corporation shareholders to a corporation might be eligible for taxes in some circumstances.

Tax Treatment 

  • Borrowed Starting Capital
    S-Corp owners are not allowed to include borrowed funds as owners' basis. Partners, on the other hand, can include their borrowed share of the money as a basis. This is significant because small-business owners can deduct business losses arising from the business on their personal income tax returns. The deductions are limited to each owner's basis. Therefore, businesses that borrow money and operate at loss in the initial years are better off as partnerships because the owners are more likely to save on taxes.
  • Tax Types
    Owners of both entity types must pay personal income tax. Active partners, in addition, are required to pay self-employment taxes. This is not the case with S corporation owners. Employee shareholders do not pay self-employment taxes. Rather, employee shareholders must earn a salary from the business and pay FICA taxes. Dormant shareholders or partners do not pay any payroll taxes. 

Formation and Maintenance 

  • Formation
    Starting a partnership is relatively easy and generally does not require filing any paperwork with the state. A business that desires S-corp treatment, however, is required to first register either as a corporation or a limited liability company. The business must meet IRS requirements to file for S-corp treatment.
  • Maintenance Requirements

Businesses treated as S corporations must file annual or biennial reports with the state. If the business is a corporation, it must hold formal meetings. These requirements do not apply to partnerships.

  • Structure

Partnerships have minimal structural requirements. The basic requirement is that the partners have equal say even if their shares in the business are not equal. Partners can even agree on a profit and loss allocation method that is not based on their respective shares of the business. S-corps that are registered as corporations is required to have a formal management structure that includes a board of directors and officers. The only basis for allocating profits and loss in an S-corp is the number of shares the shareholder has.

Liability Protection

Owners of general partnerships are exposed to liability arising from debts incurred by the partnership. The personal assets of partners can be sold to cover debts from the partnership. This can be circumvented if the owners register as a limited partnership. In this case, all but one of the partners can have limited liability. All owners of an S-corp, on the other hand, have limited liability protection.

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